When Is an Agent Paid More than his Reservation Wage? (efficiency wages)
There are lots of these “efficiency wage” models (beyond, of course, where the agent has some market power, so he bargains for a higher wage with the principal). Here are some:
1. Moral hazard. The agent must be given an inducement for high effort. If he is paid a high wage, on the threat of losing his job and future wages if he is caught shirking (whether with certainty or by auditing), he will work hard now even if his current wage cannot be conditioned on his effort.
2. Adverse selection. Paying a high wage attracts both high and low quality agents, whereas paying the reservation wage would attract only Low’s, if the High’s have a higher reservation wage. We say that the Lows earn an “informational rent” in this situation. We could have firing of the Lows after the first period, when the principal finds out their type.
3. Changing the Marginal Utility of Money. This is the reason in my 1992 Economic Inquiry paper. Pay the Congressman a lot, and he is less tempted to steal because the value of money vs. jail time decreases.
4. Asymmetric Information Bargaining Rent. This is another informational rent. There is only one agent, of known ability, but the principal doesn’t know whether his reservation wage is high or low. If the principal gets enough surplus even at the high wage, he will offer it and the low-reservation worker will get surplus.
5. Physical Strength. Maybe if the principal pays the reservation wage, the agent will be too weak to work. This reason could well apply to slaves, for example.